The Cost of Unnecessary Complexity… and How to Avoid It

The Virtue of Simplicity in the Investment Process

A few weeks ago, Advisor Perspectives published an article praising the virtue of simplicity in the investment process. One of our favorite lines from the article was:

“Our industry is in love with complexity, but complexity is costly to clients.”

We agree with this sentiment. One need look no further than the tens of thousands of mutual funds, ETFs, structured products, and hedge funds available to U.S. investors to see that complexity is the reality in our industry. It’s also clear that getting bogged down in this complexity can be both expensive and time-consuming.

Good Complexity vs. Unnecessary Complexity

That’s not to say that complexity is always a negative. In fact, complexity is a necessary consequence of the innovations that enhance our lives and society. In the financial services industry, complicated innovations have brought us a wide array of diversifying investments, lower costs, and access to new return streams.

We call this “good complexity” and strive after it ourselves.

What we conscientiously sift out is “unnecessary complexity.” The products and services in this category bring complications, but no obvious benefits. They are seductive, promising to add some “sizzle” to your portfolio (whatever that means!). They muddy the waters, making client portfolios more costly and results harder to measure. Generally, products like retail hedge funds, principal protected notes, private REITs, and fixed annuities can be found in this category. Unfortunately, these types of unnecessarily complex solutions abound.

Why Is There So Much Unnecessary Complexity in the Industry?

The natural next question is why? Why is there so much “unnecessary complexity” in the financial services industry? Wouldn’t it be better to keep things simple? As we ask these questions, we are reminded that we live in an industry rife with conflicts of interest, where money managers and advisors often put their needs ahead of their clients’ needs. For these advisors, complexity veils hidden fees, creates convenient revenue streams, and provides a veneer of “sophistication.”

Sadly, some of the unnecessary complexity also comes from a place of good intentions. Advisors can easily fall into a trap of chasing “good ideas,” creating overly elaborate portfolios, which they constantly tweak in reaction to shifting market expectations. In many cases, this type of well-intentioned, but unnecessary complexity destroys value. Any potential gains are lost to higher trading costs, more expensive tax filings, unnecessary capital gains exposure, and increased expenses.

A Need for Thoughtful Solutions

Whether issues arise from good or bad intentions, they remain issues, creating a need for thoughtful solutions. To quote the same Advisor Perspectives article:

“Builders of elegantly simple portfolios pay attention to the internal expense ratios of the mutual funds and ETFs they use. They know that actively managed mutual funds are not always too expensive and ETFs are not always cheap. They look for the best combination of cost and value”

KPP navigates this sea of complexity by taking the above approach, starting with a foundation of broad, low cost market exposure to stocks and bonds. From there, it is our job to confirm that what we implement in a portfolio is expected to add long-term value. KPP views this complexity as an opportunity to create elegantly simple solutions that are customized to you, the client. We dive into the world of complexity and chaos, and come back with only the tools that we expect to add material value – net of any ancillary costs.

In sum, we do not ignore the complexities of this industry. On the contrary, our intellectual curiosity drives us to understand the complexities of financial instruments and estate planning tools that provide real advantages, but from there we aim to protect you from unnecessary complexity and keep our solutions understandable, measurable, and affordable.

You can read the full Advisor Perspectives article here: https://www.advisorperspectives.com/articles/2017/07/10/the-benefits-of-elegantly-simple-portfolio-construction